Monday, September 08, 2008

Crisis investing: The Opportunities in Vietnam

Crisis investing is not an easy thing to do. It takes nerves of steel. After all, buying what no one else is willing to seems absolutely foolish. But in the markets, history has proven repeatedly that crisis investing can be extremely profitable.

In 1998 the Russian financial crisis nearly put a stop to the runaway gains the Dow and Nasdaq scored almost every day. Russia ran out of money. Rock bottom oil, natural gas, metals and timber prices pushed the Russian economy to the brink of disaster. The country couldn’t make the interest payments on its debt. The whole world was about to foreclose on Russia . It was a complete disaster.

But while most people were running in the other direction, a few brave investors saw the opportunity. And were willing to take the risk. It was less than a decade since Russia ’s giant economic leap forward and the herd expected the country to fall back into financial chaos. As usual, the herd was dead wrong.

Crisis investors - who are willing to buy what no one else will - saw the opportunity. If things got any worse, they’d lose 100% of their investment. But if things turned around, they stood to make quadruple-digit gains.

One group of investors pooled $50 million to buy a 1% stake in Gazprom , Russia ’s state-controlled natural gas giant. In 1998, this was considered extremely brash. After all, these investors were supposedly buying at the “worst” possible time. But the risk/reward was in their favor and they knew it. Risking 100% to make 5,000% or more is a smart bet to make with the speculative part of our portfolios. That $50 million investment is now worth almost $3 billion…good for a gain of 5,973%.

In hindsight, it always looks easy. Asia during the currency crisis, Russia when the government defaulted, oil stocks when a barrel of crude was trading for $8 a barrel…it all seems so obvious now.

To crisis invest successfully you have to find the worst possible situation, expect a rough ride for a few years, and ensure that you’re only risking money you can afford to lose. The rewards for being patient and taking on more risk than normal can be absolutely huge.

That’s why I’m getting very excited about another crisis in the making. This country’s stock market appears to have hit rock bottom. It reminds me of Russia in 1998. Yes, I think it’s a very good time to invest in Vietnam . To understand how the Vietnamese economy devolved into a state of crisis, let’s meet Trung.

Trung the Novice Investor

On the surface, Trung appears to be a regular blue-collar guy. He’s in his mid twenties. He works hard at the local water utility in Hanoi . He takes home about $300 a month and lives a reasonably comfortable life.

As a resident of Vietnam , he’s benefited from a decade of booming growth in Asia . But Trung has made most of his money by playing the Vietnamese stock market. Between 2003 and the start of 2008, Bloomberg’s Vietnam Stock Index has soared more about 800%. That works out to a 55% annualized return for the entire index.

With average returns like that, how could Trung not have done well? Because Trung didn’t recognize that he was living in a bubble.

That fact is, between 2003 and 2008, all Vietnamese investors did well. Trung went as far as mortgaging his family’s house to get more money to play the markets. It was out of control. A bubble had formed and it had to blow up...eventually. Bubbles always do. And this one was no different.

In February the overvalued Vietnamese Stock Index started to plummet. It was no longer a sell-off and traders like Trung, who were willing to mortgage the house to buy stocks, had taken on far too much leverage and had to sell, sell, sell.

The selling pressure created a dramatic downturn. The entire Vietnam index lost more than 60% of its value. But there was a much bigger bubble that had burst in Vietnam .

Vietnam is still dealing with a lot of issues as it tries to move away from communism toward a capitalist economy. One of the biggest challenges has been the rise of an unregulated over-the-counter (OTC) stock market.

Vietnam ’s OTC market involved trades between individuals across social networking sites and message boards. Bids and offers are placed on Websites and they’re completely exempt from all exchange rules. It’s tough to call it a market, but it’s where most Vietnamese private investors like Trung were trading.

On this unofficial exchange, it was common for stocks to soar on rumors. There was no way to track the performance of the unofficial market, but some stocks traded off the market would be worth five to ten times more than the same shares on the sanctioned and regulated stock exchange.

When the regulated exchange dropped 60% in less than a year, losses were amplified on the OTC market where a battalion of inexperienced investors let their greed run rampant. Many stocks traded on the OTC market fell as much as 90%.

Now - a year later after the initial sell-off started - the index is much closer to fair value. And with all the weak hands wrung dry and forced to sell to cover losses, Vietnam is looking like a buy.

I understand the concerns. Obviously, Vietnam is not perfect. It just went through a stock market meltdown similar in magnitude to the U.S. crash of 1929.

Also, Vietnam ’s official inflation has surged to more than 25%, two times higher than that of most other Asian economies. They are in the middle of a clumsy transition from central planning to a free market-based economy. It’s tough to imagine things getting any worse.

And that’s exactly why it’s time to invest. Vietnam is probably not going to get any cheaper. When everything is down there’s only one way to go, up. In fact, as you can see in the chart above the market has already started to move up.

Low Wages Will Spur Growth

Wages in China have risen 300% in the last 15 years. Vietnamese factory workers make 55% less than their Chinese counterparts. As a result, low cost Vietnam is poised to become the new manufacturing center of Asia . China has been outsourcing manufacturing activities to Vietnam for years.

In 2007 Vietnam attracted $21 billion in foreign investment. In the first 8 months of 2008, there has already been $47 billion in foreign investment, up 373% from the same point a year earlier. The major investors are Taiwan , Japan , and Malaysia . They know the value of being able to tap into Vietnam ’s cheap labor force.

There are only two easy ways to get in on the Vietnam rebound and both are traded on the London Stock Exchange. The Vietnam Holding Asset Management (LSE:VNH) is primarily focused on government owned companies going public. It currently manages more than $100 million and is completely focused on Vietnam .

The Vietnam Opportunity Fund (LSE: VOF) is a closed-end fund that invests directly in Southeast Asia . The fund is required to have at least 70% of its assets in Vietnam . For a focus on such a small and growing country, it’s a big fund with assets of $600 million. VOF is a powerful pure play on any Vietnam recovery.

Over the next year, there will be more opportunities for investors to invest directly in Vietnam . A proposed U.S. listed Vietnam ETF has been shelved and could be coming on the markets as emerging markets come back into fashion. Also, the Vietnamese government currently owns and operates more than 3,000 businesses. As long as the country goes down the privatization route, these will need to go public and some of them will be listed on exchanges in North America .

Again, Vietnam offers a tremendous opportunity for investors willing to stray off the beaten path and delve into where no one else is willing to go. Putting money in Vietnam now is crisis investing in the truest sense. So, at the Prosperity Dispatch, we always stick to a few Crisis Investing Guidelines:

1. Only put in money that you can afford to lose2.Expect to hold any shares for at least five years (economies don’t get turned around overnight)3. Get ready for a wild ride…there will be a lot of bumps along the road to recovery As long as you stick to these rules, Vietnam is well worth a look.

Imagine buying Russia in 1998, or stepping into the Asian Tigers right after the Asian currency crisis of 1997, or buying resource-rich Kazakhstan when oil was under $10 a barrel. Each of them offered quadruple-digit returns for investors willing to take the plunge.

Vietnam , with inflation soaring and its stock market tanking, offers the same kind of upside potential.